How have private markets behaved in downturns?

CIO Global Blog

18 Sep 2019

Given where we are in the current market cycle, we look to frame expectations for private markets in a potential downturn. For that, we look at historical trends and observe how private markets performed and behaved in prior downturns, including the dot-com bubble and the global financial crisis.

Given the illiquid structure of private equity (PE) investing, managers and investors were typically insulated from panic selling and less exposed to short-term pressures experienced in publicly listed companies. In addition, a 2017 study titled "Private Equity and the Financial Fragility During the Crisis"showed that PE-backed companies were more resilient in investing during the downturn, resulting in more attractive exit positioning post-crisis versus non-PE-backed companies.

On performance, private market returns were typically more modest in the two years before public equity market peaks. It is important to note that these periods were characterized with elevated valuations and higher risk of losses. Also, some managers may have opted to hold assets longer, which suppresses the internal rate of return (IRR) given it is affected by the timing of cash flows.

Source: Cambridge Associates, UBS. Graph references pre- and post-2000 and 2007 equity peaks.

However, investors who maintained allocations through the crisis benefited as vintage-year returns gradually improved as managers took advantage of market dislocations. Importantly, private equity continued to outperform public equity through the cycle, a function of funds' active ownership and ability to earn an illiquidity premium.

While investors may have avoided the lowest vintage years with perfect hindsight, market timing is very difficult and even harder for private markets —it is nearly impossible to time and control both investment and exit environments as funds go through the J curve. Adhering to a regular commitment program and investing across vintage years is a powerful way to mitigate timing risks, which can expose investors to underperforming years or lead to missing out on strong ones.

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Jay Lee, CIO Strategist, UBS Financial Services Inc. (UBS FS)Karim Cherif, Strategist, UBS Switzerland AG

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